This article is written by Harsh Gupta from the School of law, HILSR, Jamia Hamdard. This is an exhaustive article which deals with the concept of fiduciary, its obligation and theories associated with it in a detailed manner.
Fiduciary relationships are formed when one person places some trust, confidence, or reliance on another. If trust and confidence are delegated, the person has a fiduciary duty to act in the other party’s interest. Fiduciaries are those who have to act in the best interests of the other party. The party to whom the duty is owed is called the principal.
Contracts, wills, trusts, election results, and corporate relationships are all instances when fiduciary relationships are created. In the fiduciary relationship, the principal objective is for two parties to establish a relationship of trust and confidence where one party is confident that the other party is working in his or her interests and not for the benefit of another.
Scope of fiduciary obligation
Fiduciary obligations are a complex product of the interactions between the agreement agreed upon between the parties, implied obligations arising from their conduct, and legal obligations. There is one clear lesson that the fiduciary obligation imposes no duty of altruism; it is not a duty of selflessness. No blackletter principle tells a trustee that her interest should always come before the beneficiary’s in a fiduciary relationship, including trustee/beneficiary. A trustee may be a member of a class of beneficiaries as well as trustees. The trustee, in this case, is in a situation that is analogous to another traditional fiduciary relationship, a partnership, where the interests of the trustee and the beneficiary are coextensive. Fiduciaries are obligated to place the other party’s interests on an equal footing with their own, but must not prioritize one’s interest over another’s. Traditional fiduciary relationships are by no means divorced from self-serving concerns. Traditional fiduciary relationships are often entered for self-interested reasons.
The traditional theories of fiduciary relationships
Fiduciary duty has been the subject of various theories by commentators. According to these theories, the existence of a fiduciary relationship depends on whether one of four characteristics exists: (1) status, (2) reliance, (3) entrustment, or (4) assumption of fiduciary duty.
According to the most basic theory, the status theory, a fiduciary is someone who belongs to one of the traditional categories of fiduciaries, such as a trustee, agent, partner, etc.
In addition, one of the most frequent expressions of the nature of fiduciary relationships is the reliance on which one party relies. Dependence is most often caused by an unequal relationship. Fiduciary relationships, according to this theory, exist when one party relies on the other and positions trust in them. This theory has several obvious shortcomings.
Entrustment theory describes situations in which one party has conferred power on another, requiring the entrusted party to exercise discretion over the entrusting party’s financial well-being. It is somewhat attractive to consider this theory. This theory is in part derived from the classical “trust” paradigm in which one party “places” control over another party’s property.
Assumption of fiduciary duty theory
‘A voluntary assumption theory’ was developed by Professor Shepherd to achieve the benefits of Scott’s original theory while avoiding its pitfalls. Professor Scott originally defined a fiduciary as a person who undertakes to act in the interest of others.
Remedies for breach of fiduciary duty
Unlike breach of contract, breach of fiduciary duty brings a much broader range of damages to bear. The argument is that “even though the contract may be a foundation for the relationship, recovery is based on breach of the implied duty created by the relationship rather than on breach of the contract itself.” Traditionally, when someone has breached fiduciary duties, they are liable for disgorgement of profits, an action accomplished by imposing a constructive trust (a trust imposed by law rather than by intent). Accordingly, it is constituted as an equitable obligation to transfer property from the owner, on the ground that he would unjustly enrich himself if he was allowed to retain it.
New fiduciary principle
Fiduciary responsibility allows liability to be tailored to the harm caused by the breach of trust, rather than being boxed under the dreaded terms of ‘contract’ or ‘tort.’ If someone violates trust intentionally or egregiously, then it may be appropriate to award punitive damages, but not if the breach was caused by carelessness alone. In essence, the ‘new fiduciary principle’ is the understanding that fiduciary relationships can never remain static.
Fiduciary relationships are evolving, dynamic concepts which can be identified, explained, analyzed, and criticized, but they cannot be rigidly classed as one thing or another. Although courts and commentators frequently comment on fiduciary relationships as amorphous, they often analyze cases through the trustee/beneficiary relationship as the only appropriate definition. When courts reason by analogy in this way, they fossilize the concept of fiduciary obligation.
Essential elements of the new fiduciary principle
In terms of the new fiduciary principle, there is a fiduciary relationship whenever there is
- One party’s dependence or vulnerability to the other, that
- Resulting in power being conferred on the other
- As a result, the entrusted party is not able to protect themselves effectively, either through “cover” or other means, and
- Fiduciary duties are imposed on the party that solicited or accepted this entrustment.
A relationship based on trust involves vulnerability or dependence leading to the transfer of power. Fiduciary principles share most of these elements with traditional models. If dependency or vulnerability and the entrustment of power were the only criteria for the existence of fiduciary relationships, then virtually all contractual relationships would be fiduciary. Third, the practical inability to “cover” or otherwise protect oneself is a vital component of the new fiduciary principle. It reinforces the message found in both the cases and in general contract law, which is that individuals should look out for themselves, especially when entering into a contract with another. The new fiduciary principle focuses almost exclusively on the situation and conduct of the entrusting party in the first three elements. An entrusted party cannot completely determine extracontractual damages or the intense duty that accompanies a fiduciary relationship. Accordingly, the fourth element of the new fiduciary principle is the requirement to assume fiduciary status expressly or impliedly. As a result of the new fiduciary principle, a party may explicitly or implicitly request or accept a heightened duty toward the other party.
Application of the new fiduciary principle
The courts, knowingly or unknowingly, tend to award tort damages only in cases where they find fiduciary elements present. As a result, judges tend to rigidify processes if they do not recognize the reasoning behind their decisions. The doctrine of the implied covenant of good faith has been explained by cases that hold that an employment relationship cannot give rise to a tort claim. However, it is not necessary to be rigid. These cases can be understood as a new type of breach of fiduciary duty that can provide a source of law that clarifies the circumstances under which duty may be imposed and its limitations.
Hilker v. Western Automotive Insurance Co. (1931)
It was held that; “by purchasing an insurance policy, an insured is protecting himself to the best of his abilities.” In such cases, an insured cannot obtain additional insurance coverage to cover the judgment amount in excess of the limit of the first policy; the insured is not covered. The insured cannot purchase another policy to pay the judgment over the limit of the first policy. The insurance firms undoubtedly use some of the most direct appeals to the human want for security and safety in their solicitation and acceptance of financial power: “You’re in good hands with All state.”
In the context of third-party settlement, courts have generally permitted extracontractual damages for breach of the implied covenant of goodwill and fair dealing in part because these aspects of the insured/insurer relationship are present. Analysis of these cases, however, clearly illustrates the new fiduciary standard.
Gruenberg v. Aetna Insurance Co (1973)
Courts have tended to be more conservative in permitting tort damages when an implied covenant of good faith is violated. In Gruenberg, the California Supreme Court held that when an insurer acted unreasonably and refused to pay a claim, the insured could claim tort damages. In its ruling, the court stated:
Previous cases examined the insurer’s duty to act fairly and in good faith in handling claims asserted against the insured by third parties, referred to as the insurer’s “duty to accept reasonable settlements.” In the case before us, we look into the insurer’s responsibility to deal fairly with the claim of an insured, particularly a duty not to withhold unreasonably payments due under a policy. There is no difference between the two aspects of the same duty. However, defending, settling, or paying are not requirements outlined in the policy. It may also give rise to a cause of action in tort for a breach of an implied covenant of good faith and fair dealing if it refuses, without proper cause, to compensate its insured for a loss covered by the policy.
The more serious problem with the argument is that it ignores the new fiduciary principle inherent in the first-party context. There is only one difference between first- and third-party contexts, and that is the degree to which one acknowledges that when an insured buys an insurance policy, he or she gives the insurer power over their financial interest.
An insured who surrenders all control over the litigation and settlement to the insurer confers power on the insurer in a third-party context. When an insured is covered under a first-party policy, their money is surrendered in exchange for a promise from the insurer to provide the insured with adequate financial protection, as defined by the policy.
Foley v. Interactive Data Corp.(1988)
The Foley court (Courts of appeals) determined that even making use of “special relationship” analysis when considering tort damages based on violations of the implied covenant of good faith, the employer-employee relationship was not sufficient to justify tort remedies.
In support of its ruling, the Foley court distinguished the employer-employee relationship from the insurer-insured relationship. There are four main differences highlighted by the court. When an employer breaches its employment contract, an employee is not in the same tough position as an insured is in when the insurer breaches its contract. A wrongfully terminated employee cannot seek out another job to mitigate damages when an insurer takes such actions. However, a wrongfully terminated employee can (and must, to mitigate damages) make reasonable efforts to obtain alternative employment. Additionally, employers do not have a “quasi-public” responsibility that warrants a higher standard and employers do not in any way provide the same benefits to their employees as insurers do. On the other hand, small businesses do not offer the same amount of financial security as insurance companies do.
However, the California Supreme Court ruled that no tort damages could be awarded for breach of implied covenants of good faith and fair dealing resulting from wrongful termination of an employee. It appeared that the Court was reluctant to adopt an approach that would permit extra-contractual damages when a party to a “special relationship” breaches the contract in bad faith.
Commercial Cotton Co. v. United California Bank (1985)
When a bank negligently paid a cheque drawn on a customer’s account, the California Appellate Court found that it failed to uphold the implied covenant of good faith and fair dealing by raising false defences, refusing to compensate the customer for losses, and refusing enforcement of the covenant. Using this analogy, the Court concluded that an account customer and a bank have a relationship comparable enough to that between an insured and an insurer to warrant extra-contractual damages if certain implied covenants of good faith and fair dealing are breached.
In this case, the Court found that banking and insurance have a lot in common, both being highly regulated industries that provide essential public services substantially impacting welfare. Apart from state or federal regulatory oversight, the depositor of a non-interest-bearing checking account is reliant on the bank to which he or she entrusts his or her funds and depends on its honesty and expertise to protect the funds. In addition to providing services to depositors, banks use party policy defences to generate profits through monitoring deposits and withdrawals. In exchange for the convenience of not having to deal in cash and the security that comes with having the bank safeguard those funds, the depositor allows the bank to use those funds. Banks have a quasi-fiduciary relationship with their depositors, and depositors reasonably expect that a bank won’t claim nonexistent legal defences to avoid reimbursement when the bank negligently disburses funds. According to the jury, the bank’s claimed defences are irrelevant here, and the bank’s attempt to prevent an innocent depositor from recovering money entrusted to and lost through the bank’s negligence is a breach of the covenant of good faith and fair dealing within the bank.
Garrett v. Bankwest, Inc (1990)
To prove a fiduciary relationship between the lender and borrower, the Court noted that “activity on a day-to-day basis or the ability to compel the borrower to engage in unusual transactions” is essential. In Garrett, the plaintiffs contended that the bank had acted as a friend, confidant, and business advisor to their 5400-acre farm and cattle ranch, beginning when the Garretts decided to expand the ranch’s crop-growing potential by installing a costly irrigation system. By signing a memorandum requiring the Garretts to adhere to a cash flow statement, the bank eventually took full control of the ranch’s finances, the Garretts claimed.
According to the South Dakota Supreme Court, this transfer was not significant enough to trigger a fiduciary relationship, so the Garretts could have adequately protected themselves. In its judgement, the Court noted that the cash flow statement and memorandum represented a negotiated agreement between the Garrett family and the bank for the repayment of the Garretts’ operating loan. According to the Court, the Garret family had the right to refuse to renew their loan with this bank. Banks did not control the Garrett family’s day-to-day operations and did not have any business expertise to compare with the Garretts. Therefore, the Court ruled that the Garretts and the bank did not have a fiduciary relationship. According to this case, courts in lender liability cases carefully evaluate the alleged facts, permitting extracontractual damages only in cases in which the borrower fully entrusted the lender with determining its fate and is no longer capable of protecting itself.
Moore v. Regents of the University of California (1990)
In recent years, courts are now applying fiduciary principles more directly to doctor-patient relationships, unlike traditional ones. The California Supreme Court held that the patient may claim that the doctor violated his fiduciary duty when he failed to disclose details of his research and economic interest in tissues and blood taken from the patient during the process. The Court recognized there was no obligation for the physician to not experiment on the patient or to carry out research on their bodies. In other words, a fiduciary obligation does not require the fiduciary to sacrifice its interests. According to the Court, the fiduciary and the beneficiary might share a common interest: “Progress in medicine often depends on physicians, such as those at the hospital where Moore received treatment, who conduct research and care for patients simultaneously.”
The Moore case illustrates the new fiduciary principle pretty well. This is an important decision applying fiduciary obligations to a relationship that was not traditionally viewed as fiduciary. The fiduciary is an overly broad term in some respects, the court noted. The term “fiduciary” refers only to a physician’s obligation to disclose all facts relevant to the patient’s decision. Physicians are not financial advisers to patients. Physicians must disclose possible conflicts of interest not just to protect their patients’ financial interests, but also because certain personal interests may affect their professional judgment.
Constraints on and implications of the new fiduciary principle
Inherent constraints on the new fiduciary principle
Fiduciary principles have been criticised for their amorphous nature, including their potential to open the floodgates for frivolous claims and punitive awards of damages. This stock argument can be answered in at least two ways. First of all, there is no doubt that this argument has been made against every tort ever created, torts now considered well-established, settled, and hornbook law. Second, the new fiduciary principle is actually rather limited in its scope. It limits the application of the new fiduciary principle that benefits must be limited to those who cannot realistically cover themselves.
Possible procedural modifications of the new fiduciary principle
There is a widespread belief that juries will reach inconsistent, irrational verdicts and award excessive damages. An example of this is the fear that damages will be excessive. It is possible to respond to this objection in several ways. This argument is a conservative reaction to inescapable changes in common law, as is the case with any new tort claims. There are many members of the legal community who simply reject change. Uncertainty brings challenges to those who feel more comfortable with the existing rules and system.
Explicitly acknowledging a new fiduciary principle has several significant advantages. Fiduciary obligations provide a better understanding of what a contracting party owes to its partners in certain “special” relationships. Fiduciaries are held accountable to a combination of (1) the agreements expressly reached by the parties to the relationship, (2) obligations implied by their conduct, and (3) obligations expressly demanded by law. Due to the wide range of fiduciary obligations arising from a variety of sources, neither the ‘tort’ theory (which defines only duties implicit in contracts) nor the ‘contract’ theory (which defines only obligations arising from independent relationships) can explain tort damages resulting from breach of contract.
However, the description of fiduciary obligations here is still inherently ambiguous, despite being clearer than previous formulations. Even a small degree of clarity can be more cruel and arbitrary than the illusion of true clarity. Furthermore, until courts can come up with a better reason to allow extracontractual damages in breach of contract cases, some courts will eliminate causes of action while others will create new ones. As a consequence, litigants would have alternative causes of action such as defamation, intentional infliction of emotional distress, and bad faith denial of the contract with court denials of summary judgment motions. A new fiduciary theory will rise from the ashes of previous theories that have been eliminated by judicial opinions just as the mythical phoenix does.
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